Currency traders have been betting against the Saudi peg, and those of other regional oil producers, in the wake of oil’s price collapse.
Societe Generale said yesterday it saw at least a 25% chance of a near-term devaluation or 40% if oil prices stay at current levels throughout 2016.
But in Saudi Arabia’s largely US dollar-denominated economy, breaking the peg would immediately raise the price of goods, hitting living standards.
Combined with other pending painful economic reforms, this could lead to unrest in a country where the unwritten social contract swaps citizens’ obedience and allegiance to the king for good government services and a share in oil wealth.
“Devaluation of the currency or depegging would self-inflict destructive economic pain. It would be catastrophic,” said John Sfakianakis, a Riyadh-based economist.
Some diplomats living in Saudi Arabia say privately that a break in the peg is the single biggest political risk facing a country already embroiled in a war in Yemen and suffering periodic deadly attacks by militants.
The biggest Arab economy has only a small manufacturing base and almost all goods come as dollar-priced imports, so a cheaper riyal would instantly make normal Saudis feel poorer without providing any benefit to the wide economy via cheaper exports.
Saudi citizens have so far been mostly insulated from the impact of lower oil prices. The cost of fuel is cheap, even after a 50% rise in petrol prices, and the cuts in spending have yet to be felt in employment.
But change is coming. Riyadh promised in its 2016 budget statement to slow increases in the state payroll, meaning few new government jobs, and as Saudi private sector growth closely tracks government spending, this means few private sector jobs.
Threats to the economic basis for the Al Saud dynasty’s legitimacy could barely come at a worse time. It is going through a prolonged and delicate shift to a new generation of rulers after six decades of rule by a line of brothers.
Riyadh’s overarching regional rivalry with Iran has pushed Saudi Arabia into a war in Yemen that has cost the lives of 375 of its own citizens, while attacks by jihadists, including a mosque bombing last week, have killed dozens inside the kingdom.
The impact of a sudden rise in living costs and a collapse in purchasing power in such circumstances from a devaluation could be explosive.
“Especially at this time, because of the difficult reforms coming down the road, it would be very hard to sell to the public,” said Jamal Khashoggi, head of al-Arab news channel.
The Saudi Arabian Monetary Agency (SAMA), the central bank, has vowed to maintain the peg of 3.75 riyals to the dollar come what may.
With access to US$609 billion (RM2.52 trillion) of foreign exchange reserves built up during years of higher oil prices, it has a way to go until these are exhausted.
“We think the high level of reserves allows the Saudi Arabian Monetary Agency (SAMA) to maintain the current exchange rate regime for the time being,” UBS research said.
“However, challenges are significant, since fiscal buffers might be exhausted within five to six years without any adjustments.”
One-year dollar/riyal forwards – contracts used by counterparties to lock in a future exchange rate – were around 550 points yesterday, well down from the record 1,000 points earlier this year as some banks and funds hedged against the risk that Riyadh would scrap the peg.
The previous record was 850 points hit during a bout of speculation against the riyal in 1999.
Still, some Saudis say friends or colleagues have started to transfer cash overseas – a sign of fears about the riyal’s resilience.
Absent an agreement with a wide array of other oil producers to rein in output, Saudi Arabia appears set to continue its strategy of defending its share of the crude export market, meaning energy prices are likely to stay low.
Societe Generale’s report said that unlike in past periods of stress, when Riyadh maintained its currency peg despite low oil prices, it was this time running far higher fiscal deficits in an energy market that had less room to recover.
“The probability of the pegs failing is one of ability and willingness to defend the regime at all costs. The market is testing the authorities’ willingness, and rightfully so,” the French bank said in a note.
Related news ---------------------------------
Saudi Arabia struggles to cope with cheap oil
Saudi Arabia has managed to buy itself a couple of months.
The global rout of oil prices is taking its toll on the kingdom's bottom line. The country has been forced to cut government spending in its upcoming budget and increase production of crude oil—even though its hardly worth pulling it out of the ground.
Still, the world's largest producer of oil appears on a crash-course for bankruptcy as early as of 2018, according to a new Big Crunch analysis.
Many oil-dependent nations are having to dig deep to balance budgets, with crude oil fetching so little on the global market. Money-rich nations like Qatar and Kuwait look to be getting by, while poorer nations like Libya have descended further into strife and civil war. Oil would need to be selling for $269 a barrel for Libya to balance its budget, according to the IMF.
Saudi Arabia is somewhere in between: A stable nation with a sizable backup of reserve assets, somewhere around $624 billion as of December. But much of that stability is bought with government jobs and generous public spending and with falling oil prices, the country has had to dip into its reserve assets to make up the difference.
Of course, the analysis depends on no major economic changes or events effecting Saudi Arabia. It also assumes oil prices remain low, which experts consider likely for the time being.
CNBC looked at the country's finances back in August, when oil swung between $48 and $41 a barrel. It had fallen a long way from its highs of $65 a barrel a few months before, but our lower estimate for its direction was way off. At the time, CNBC estimated the Saudis would be broke in August of 2018, yet that was based on oil at $40 a barrel and before they cut public spending.
The 2016 Saudi budget includes a spending cut of 13.8 percent from 2015 levels, though projections from Barclays puts that cut closer to 5 percent. Even so, the country is expected to reach a budget deficit of 12.9 percent of GDP in 2016, according to the investment bank.
In addition to spending cuts, Saudi Arabia has increased production, to more than 10 million barrels a day as of October, the latest figures available from the Energy Information Administration (EIA).
While the increased production helps to add a bit to the Saudi's bottomline, it does nothing to alleviate the glut of oil on the global market. Global production is projected to be 95 million barrels a day in the first quarter of 2016, and consumption around 94 million, according to the EIA.
The economic slowdown in China is often blamed for much of the decreased demand. On the supply side, U.S. shale producers have proved more durable in the harsh economic climate than the Saudis expected. Iran, too, has entered the oil market in recent weeks as Western sanctions have been lifted. The Islamic Republic produces about 1.1 million barrels a day and has said it wouldn't consider slowing production until its grown to 1.5 million.
Earlier hopes of a deal between OPEC nations and Russia to cut production were dashed on Friday when an unnamed Iranian official told the Dow Jones news agency that the country would not participate.
Saudi Arabia has said before that it would agree to cut production if both OPEC members and non-OPEC nations would do the same. - 31 Jan 2016 CNBC
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